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Two Fallacies Concerning Central Bank Independence

  • Bennett T. McCallum

This paper takes issue with two basic conclusions prevalent in the literature on central bank behavior. First, the paper argues that it is inappropriate to presume that central banks will, in the absence of any precommitment technology, necessarily behave in a 'discretionary' fashion that implies an inflationary bias. Since there is no functional connection between average rates of money creation (or inflation) and policy responsiveness to cyclical disturbances, it is entirely feasible for the bias to be avoided. In other words, there is no necessary tradeoff between 'flexibility and commitment.' Second, to the extent that the absence of any absolute precommitment technology is nevertheless a problem, it will apply to a consolidated central bank plus government entity as well as to the central bank alone. Thus contracts between governments and central banks do not overcome the motivation for dynamic inconsistency, they merely relocate it.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5075.

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Date of creation: Mar 1995
Date of revision:
Publication status: published as American Economic Review Papers and Proceedings, vol. 85, no. 2, pp. 207- 211 (May 1995).
Handle: RePEc:nbr:nberwo:5075
Note: EFG ME
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  1. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Working Papers in Applied Economic Theory 94-05, Federal Reserve Bank of San Francisco.
  2. McCallum, Bennett T., 1993. "Discretion versus policy rules in practice: two critical points : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 215-220, December.
  3. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  4. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
  5. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  6. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
  7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  8. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
  9. Alesina, Alberto & Tabellini, Guido, 1987. "Rules and Discretion with Noncoordinated Monetary and Fiscal Policies," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 619-30, October.
  10. Robert P. Flood & Peter Isard, 1989. "Monetary Policy Strategies," IMF Staff Papers, Palgrave Macmillan, vol. 36(3), pages 612-632, September.
  11. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  12. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
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